The rationality of retirement preservation decisions : towards a scientific model

Abstract

There is worldwide concern that individuals are not saving sufficiently for retirement. Low savings rates, coupled with a lack of preservation of retirement funds when individuals move jobs, could have adverse repercussions on the ability to retire with sufficient funds. The traditional response to low preservation levels has been to impose taxes on cash withdrawals and a move is underway in South Africa to potentially mandate preservation. All these interventions assume that individuals are not acting rationally when they take a cash payout, however this assumption of irrationality has not been tested. Therefore, the aim of this study was to determine the factors that lead to low preservation levels in order to determine whether intervention is required to increase preservation, and if so, what form it should take. The study consisted of two phases. Phase one carried out a critical, multidisciplinary literature review to construct a conceptual model of the factors which potentially lead to low preservation levels. According to this model, these factors could arise from rational decision making in line with consumption smoothing behaviour linked to the life cycle hypothesis or irrational decision making arising from behavioural factors linked to bounded willpower or bounded rationality. The resultant model highlighted the distinct differences in the drivers of rational and irrational behaviour and therefore, the distinctly different interventions required. Phase two of the study focused on the empirical testing of the conceptual model to obtain an understanding of the relative importance of the factors. This phase made use of an analytical survey to test relationships between the predictor variables identified in the conceptual model, and the outcome variable which is whether the individual preserved funds when moving jobs. The data was analysed with logistic regression techniques. The study found that behavioural factors play an important role in explaining the preservation decisions made by individuals. In particular behavioural factors related to bounded rationality as a result of the inherent computational complexity of the decision making environment emerged as important explanatory variables. This appears to indicate that solutions should focus on decision support and guidance to assist individuals in making optimal decisions. This study makes a unique contribution to the field of retirement finance and decision making as it highlights the role that behavioural factors play in retirement preservation decisions. The implications regarding which interventions are best suited to assist in optimal decision iv making are informative for policy makers, providers of retirement products and financial advisors, as well as sponsors and members of retirement funds.